Aber Diamond Corporation F4Q07 (Qtr End 1/31/07) Earnings Call Transcript

TRANSCRIPT SPONSOR

Aber Diamond Corporation (ABER)
F4Q07 Earnings Call
March 30, 2007 9:00 am ET

Executives

Bob Gannicott - Chairman and CEO
Alice Murphy – CFO
Tom O'Neill – President, Harry Winston

Analysts

Irene Nattel - RBC Capital Markets
Stephen Walker - RBC Capital Markets
Gary North - Canadian Press
Steven Butler - Canaccord Capital
Brian MacArthur - UBS
Tanya Jakusconek - National Bank

Presentation

Operator

Good day ladies and gentlemen and welcome to the year end 2007 Aber Diamond Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, your Chairman, Mr. Robert Gannicott. Please proceed.

Bob Gannicott

Good morning, ladies and gentleman and welcome to Aber Diamond Corporation’s webcast and conference call for the period ended January 31, 2007.

I would like to direct your attention to our slide on forward-looking information and remind you that during this call some of the statements that we will be making concern matters that are not historical facts. These forward-looking statements are based on currently available information, depend on certain assumptions and are subject to factors including the risks and uncertainties which could cause actual results to differ materially from what we currently expect. For a more detailed discussion of the relevant factors, assumptions and risks relating to these forward-looking statements please see our most recent disclosure documents which are publicly available on SEDAR.

Moving on to the presentation we are very pleased to present record earnings for the year linked to increased diamond production from the Diavik mine as well as increased sales from Harry Winston. By concluding the purchase of 100% of Harry Winston, Aber has brought the knowledge bases of the two most important ends of the diamond spectrum together in one diamond company that delivers improved pricing both in rough diamond sales from the mine and polished diamond purchases for jeweler.

The Diavik mine is developing both an underground mine and a new open pit while our jewelry business continues to open more stores in prime luxury retail locations. These expansions increased both the sales volumes and the security of both of our operations and therefore, our revenue base.

I am now going to hand the call over to Alice Murphy, Aber’s Chief Financial Officer, who will discuss the annual and fourth quarter financial results. She will be followed by Tom O'Neill, Aber’s President responsible for the Harry Winston business. I will then return to conclude our side of the call before we take your questions.

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Alice Murphy

Thank you, Bob. Sales growth of 11% over last year reflects another step in the continued growth pattern of both of our operating segments. Since the commencement of commercial production in fiscal ’04, our mining revenue has increased almost fourfold from $96 million to $333 million.

Similarly, our retail operations continue to achieve strong sales increases, posting a $35 million year-over-year increase in fiscal ’07 and a $58 million year-over-year increase in fiscal ’06, remembering that fiscal ’05 was a ten-month period for our retail operations. Retail revenue for fiscal ’07 was $226 million over 13 locations as compared to $191 million in fiscal ’06 over ten locations. In this regard, we posted increased sales in each of the fiscal ’07 quarters over the comparable period of the prior year.

Our gross margin of 49% for both the year and the fourth quarter is anticipated to track in the 50% range going forward into fiscal ’08. Breaking this out by segment, our mining and retail margins came in at 50% and 48% respectively, compared to 59% and 51% for the prior year; and 53% and 47% for fiscal ’05.

Running through our margins on the retail side is the amortization of the step up of inventory value relating to both our initial 51% HW acquisition in 2004 and the balance of our ownership acquisition in the past September. In the absence of this step up, our retail gross margin is consistent with last year’s margin at 51%.

From a mining perspective, the early closure of the winter road led to higher fiscal ’07 mining costs, with a consequent impact on the margins in each of the four quarters. Our Diavik cash operating cost per carat were $25 for the 12 months ended December 31, 2006 and $23 for the comparable 12 months of the prior year. This relatively stable cash cost per carat, despite the higher fiscal ’07 cost, is largely due to the increase in the Diavik production for which Aber’s 40% share totaled 3.9 million carats in calendar ’06, compared to 3.3 million carats in the prior year.

SG&A on the retail side increased to 47% of sales compared to 45% for the prior year. Included in the fiscal ’07 SG&A is $6.3 million of deferred compensation triggered by the remaining acquisition of Harry Winston. In the absence of this specific charge, SG&A as a percentage of sales would have been 44%. Mining SG&A expense for the year remains consistent with that of the previous year.

Our effective tax rate for the year on a consolidated basis decreased to 25% from 45% in the previous year. In particular, this resulted from a decrease in future income taxes amounting to a savings of $17 million, but the balance provided by a 3.5% lower statutory tax rate and the favorable impact of the foreign exchange.

Earnings per share for the year totaled $1.79 compared to $1.40, representing single year growth of 28% and almost a twofold increase over that of fiscal ’05. Notwithstanding the significant growth in our earnings per share, our cash EPS was $3.18 in the current fiscal year as compared to $3.57 for fiscal ’06, resulting from a higher proportion of non-cash FX gains and a reduced future income tax charge in our current year’s results as compared to that of the prior year.

Our cash flow from operations totaled $178 million for the year, as compared to last year’s figure of $162 million. Capital expenditures for the year were $120 million, of which $100 million related to our continued development of the Diavik mine and the balance of $20 million related to three store openings and refurbishments.

Looking forward to fiscal ’08, our budgeted CapEx is $142 million, split $110 million for the mining segment, including capital dedicated for underground development; and $32 million for retail.

Our robust earnings and cash flow from operations has maintained a strong working capital balance of $164 million.

I will now hand the call over to Tom O'Neill.

Tom O’Neill

Thanks Alice. It’s once again my pleasure to review with you the performance of the company’s retail segment. This year, we built on the prior year’s strong performance and secured ourselves firmly on the growth curve envisioned when we acquired our interests in Harry Winston. Our track record in building and expanding the Harry Winston business from our initial purchase of majority control in 2004 has been consistent. Our belief in the ability to maintain the growth led us to acquire the outstanding minority shares in Harry Winston during the third quarter of the year, significantly ahead of schedule by about three years.

The acquisition of the remaining portion of Harry Winston resulted in the accounting impact that Alice has discussed. Removing the accounting treatment of the acquisition, on a day-to-day operating level the business at Harry Winston met our targets. That is to say, we increased sales by 18% over the prior year, we maintained our gross margin percentage at 51%, we reduced our SG&A as a percent of sales by 4 percentage points. Together, these efforts resulted in a pre-acquisition increase of 33% of earnings from operations.

Our top line gains were a result of several factors which we have previously discussed with you, including our new stores in key markets with our new format that provides a refined, luxurious environment.

Second, we introduced new product designs and strengthened our product offering in traditional Harry Winston product segments.

Lastly, we revitalized and refocused our marketing and advertising efforts.

When we initially purchased our interest in Harry Winston, the retail network consisted of six salons or stores; two in the U.S., two in Europe and two in Japan. By the end of this past year, we increased the network to 13 locations, strengthening our presence in the U.S. and Japan, the world’s two largest diamond jewelry markets, with the addition of four salons in the U.S., one in Japan and introducing Harry Winston locations in Taiwan and in the United Kingdom.

We also relocated and renovated the Beverly Hills salon to a grander location, where we have introduced the refined store concept that creates an elegant setting for Harry Winston jewelry and watches, and offers our clients the ultimate luxury shopping experience.

As we continue to expand our sales base, we look to strengthen our presence in our core markets of the U.S. and Japan, as well as to present the brand to centers of new and emerging wealth. This year we plan on opening stores in Chicago; in Beijing, China; to relocate our Osaka boutique to a flagship location, which will actually open in next week; to introduce a new men’s jewelry and watch boutique in Roppongi Hills district of Tokyo, Japan which in fact opens today – I suppose because of the time differences may have happened already. We are also looking seriously at Nakoi, Japan and Hong Kong.

In the second quarter we introduced to you the new collections which we launched in time for the holiday season. Examples of the Vine and Garland collections are shown on slide 9. These new items draw from the classic cluster designs of Harry Winston jewelry and are offered in a full range of prices and pieces up to $300,000. We have had good success with these introductions and they were positively received by the marketplace.

These new collections continue to improve on the depth and the range of the current product offering in the non-bespoke segment of our business and are typical of the uniqueness of the Harry Winston look; that is to say multiple shapes of diamonds in fluid platinum settings and mounted at various angles to maximize plate refraction.

In 2004 when we acquired our interest in Harry Winston, we introduced an advertising campaign, photographed by arguably the world’s foremost portrait photographer, Richard Avedon. An example of that campaign is shown on slide 10. It was developed in a very short period of time, set to refresh the image of the brand to highlight the versatility of our client base, both in terms of lifestyle and age grouping, as well to focus our message on high-end diamond jewelry.

The Avedon campaign succeeded in a remarkably brief period, and contributed to the sales growth we saw over the next two years. This past year, we refocused the advertising as shown on the slide, we built on the Avedon campaign and shifted from a predominantly lifestyle focus with people to one that highlights our product and zeros in on the jewelry concept of the brand.

Drawing on the marketing heritage of Harry Winston, we introduced the Animal campaign. Today’s campaign draws its inspiration from successful advertising creative images used by Harry Winston throughout its long history. The striking images differentiate us in the print media and highlight the uniqueness of our designs, the brilliance of our diamonds and the creativity of our presentation, both in our images and in our salons, both of which create a dramatic setting in the sense of what is refined and luxurious.

For watches, we introduced the Hands campaign, which illustrates the uniqueness and wearabililty of our timepieces as well as the technical sophistication of the offer. An example of each of these campaigns is shown on slide 11.

In both our jewelry and watch advertising, we have stressed exclusivity and highlighted our broader product offering with the objective of continuing to build awareness of the brand and reinforcing the appeal of Harry Winston designs.

On the private jewelry side, or the bespoke business, we concentrate our marketing efforts in a much less public way. We focus on private selling exhibitions, private commissions and unique, one-of-a-kind designs offered in an ultimate luxury experience and environment. Our clients expect discretion and very personal service upon which Harry Winston has built and protected its reputation.

The continued introduction of new designs, revitalized and focused marketing and expansion into new markets, and a broadening product offering all combine to give us confidence that the underlying business will remain strong and that we will continue to meet our growth objectives.

I would now like to hand the call back to Bob.

Bob Gannicott

Thanks, Tom. Well last year our mining operations suffered significant additional costs due to the very early closure of the seasonal winter road that delivers fuel and other freight to the mining operation. This necessitated expensive airlifting to maintain the production throughout the year.

This year, in contrast, the winter road resupply, at record levels, has already been completed as a result of improved management systems and a normal winter. Our 40% interest in the Diavik diamond mine delivered a record 3.9 million carats of rough diamond production last year, entirely from a single open pit. The development of an underground mine to extract ore from the lower portions of three of the ore bodies is now well advanced, with final production approval expected around mid year.

Engineering work is also underway on the A-21 Kimberlite pipe, including the extraction of an underground bulk sample to determine a diamond price estimate of an accuracy which would allow it to be included in the ore reserves, and therefore the mine plan, by mid year

In both of these items are included, the mine plan then supports a production level of 2.3 million tons per year until 2021 and closure in 2023, assuming that no further ore reserve additions are discovered. However, early stage exploration work around and below the four pipes in the mine plan has already identified extensions of these pipes, which further work may bring into the reserve base.

Our share of the Diavik production is sorted in Canada and India into thousands of different technical classes before being aggregated into more than 50 different sales categories. These sales assortments are specifically tailored to the shifting demands of the various polishing companies in India and Israel that are our customers for the mine product.

Our sales assortments are applauded by our customers for their consistency and accuracy. Aber’s core customers for rough diamonds are also core suppliers to Harry Winston of the high quality polished diamonds demanded by its international clientele. This has the jeweler to grow its sales to $226 million last year at a gross margin of 51%, compared to $129 million at a gross margin of 45% prior to our purchase of this prestigious brand.

Looking to the future, the global mine supply of rough diamonds is not expected to grow appreciably over the next ten years, while demand increases on the back of global economic expansion, especially in the high growth areas of India and China. For the first time since the discovery of the first non-alluvial diamond deposit in what became the Kimberley District of South Africa in 1867, the diamond industry now faces a prolonged supply shortage.

With Aber and Harry Winston, we have created a unique business proposition, well placed to benefit from the dynamics that will continue to change the diamond industry. We anticipate expansion of size of our existing businesses over the coming year, while we have actively seek accretive business opportunities wherever our unique, combined knowledge base can bring added value.

Thanks for listening to us and we would now be happy to answer some questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Your first question will come from the line of Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

Good morning, gentlemen. A few questions if I may on Harry Winston. First of all, if we look at the sales growth from the existing network, can you first of all quantify it -- and I am sorry, I don’t have the presentation in front of me in case it is in there -- but also if you could talk a little bit about whether the growth came from higher spend from existing customers or an expansion of the customer base?

Tom O’Neill

Irene, I think you know we don’t break the business down that way. I can give you some kind of an overview. The existing business is really a list of existing international clients who have residence in several places in the world where they choose to buy from Harry Winston in a given year. We actually don’t have very much control over that.

Certainly, the physical growth of the business has been dramatic over the past two years, and you can see certainly that the new locations have added significantly to our business.

Irene Nattel - RBC Capital Markets

Thanks, Tom. A question on the gross margin impact in Q4. I recognize that is an accounting adjustment. But it was there in Q3, it was there in Q4. Should we be expecting a similar kind of impact in Q1 and Q2 or even further in FY08?

Alice Murphy

Absolutely. That adjustment is going to roll through in two stages, one relating to the first and one relating to the second phase of the acquisition. The impact will clearly decrease over time but you should definitely expect it going through all of FY08.

Irene Nattel - RBC Capital Markets

Thanks, Alice. The receivables write-off in Q4, is that something that happens on an ongoing basis or was that also somehow related to the acquisition?

Alice Murphy

No, it has nothing to do with the acquisition. It related to a very specific account and it was actually the reversal of that. So it’s not anything that we anticipate going forward.

Irene Nattel - RBC Capital Markets

That’s great. Can we get the depreciation specific to Harry Winston in the quarter?

Alice Murphy

It is not something that I have in front of me right now.

Irene Nattel - RBC Capital Markets

If there is any way that we can get it, if you could email it that would be great.

Alice Murphy

Again, it’s not something that we break out. We give our mining segment and our retail segment down to the earnings from operation and it’s not a number that at this point, is rolling out.

Irene Nattel - RBC Capital Markets

Thanks, Alice.

Operator

Your next question comes from Stephen Walker - RBC Capital Markets.

Stephen Walker - RBC Capital Markets

A couple of questions, first of all on taxes in financial 2008. Alice I am wondering if you can give us some guidance there with respect to both segments -- Harry Winston as well as the Diavik operating segment, please?

Alice Murphy

As you know, we had a benefit this year of $17 million that just was our future income tax that is part of the go-forward benefit on the mining side, it is a 3.5% reduction in the statutory rate. Looking at the Canadian budget in terms of whether or not there is an impact either in the federal budget or in the Ontario budget and where we are looking, we don’t really see an impact.

One of the big issues was the restriction of deducibility of interest paid on debt used to invest in foreign affiliates. We do have an investment in a foreign affiliate which of course is Harry Winston, but the budget grandfathered that deductibility. From an Ontario budget perspective, it is just a modest win.

Looking forward I think what we need to do is pull out those non-cash items, take into effect the statutory rate decrease and I think that should get you in a good position from the mining side.

From a retail perspective we still have ongoing NOLs , particularly in the U.S. and we intend to utilize those.

Stephen Walker - RBC Capital Markets

Just to put numbers to paper here, it looks like it is about 28% to 30% on the mining side, and effectively nothing on Harry Winston side?

Alice Murphy

Well, I don’t want to comment on that because I am not sitting here with numbers and paper but if you take what I have just given out. Perhaps Stephen, if you want to call me back, we can go through that when I do have that moment.

Stephen Walker - RBC Capital Markets

Okay, thank you Alice. Just if I could follow-up, Bob, with a question on disclosed revenue per carat in the quarterly numbers. My understanding is revenue per carat as disclosed, as recognized is on anything that has been sold in the quarter and not either work-in-progress or inventory -- obviously sitting in unsold.

On the other side of that equation, just to match it, the cost per carat mined again matches anything that has been sold and nothing that has been held in inventory, just on that revenue recognition and costs?

Bob Gannicott

Well first of all, because Rio Tinto sells the same mix of production that we do, antitrust regulations don’t allow us to actually disclose our achieved pricing per carat. So we have never disclosed that and we are not allowed to.

The other issue in respect to trying to look at that on A quarterly basis is the mine delivers four size streams of diamond production and there are four recovery streams in the plant, different bins in the plant. These are never completely cleaned out as it were at the end of each cycle. This is just a continuous process, so the mix of large versus small and therefore expensive versus cheaper diamonds that we receive each month, and therefore each quarter, varies.

We then bring that all down to the sorting level and of course our objective is to sell the expensive diamonds as quickly as we can, because it’s where most of our revenue recognition comes from. The smaller, cheaper diamonds, there is a much bigger volume of them, they therefore take longer to sort. We are achieving some economies by having quite a large part of that sorted in India now, and that also then implies a longer timeline on those than it does on the larger diamonds.

I would simply say that you can’t really look at our quarterly numbers and start trying to see through changes in diamond pricing.

The other effect is going at the mine now is that we have put in some circuitry to recover more of the smaller diamonds and this adds revenue, of course, it increases the grade, if you want to call it that. If we recover more diamonds we therefore do receive more dollars but, of course, adding more small diamonds to the mix does reduce the average diamond price.

All of these sort of effects interact on one another. As I say, therefore, I don’t think that one can make an intelligent view of what average diamond prices are on quarterly basis. You really need to look at a full year.

Stephen Walker - RBC Capital Markets

Great, thanks for that.

Bob Gannicott

If you would like to more detail on that by all means, call me back.

Stephen Walker - RBC Capital Markets

Great, thank you for that.

Operator

Your next question comes from Gary North - Canadian Press.

Gary North – Canadian Press

Good morning. I probably should be talking to Rio Tinto about this, but I’m wondering if you can comment on what sort of global warming assumptions are being incorporated in transport cost expectations going forward at Diavik?

Bob Gannicott

I just returned from there and we just had a big meeting about it. I can certainly answer that one for you.

What happened last year when the winter road was such a failure with one of these sort of one in one hundred years effect on the climatology up there to do with the positioning of the so-called Arctic high pressure zone, it delivered a very cold winter in Russia – something they hadn’t seen for 100 years – but it delivered a winter in Northern Canada that was warmer than we had seen for 100 years.

However, there is clearly also a gradual warming trend of which these peaks and troughs are sort of aberrations on the general signal, if you’d like. This is being now discussed on the basis of, obviously part of the winter road that is problematic is the southern end. Not so much because being at the southern end of the road is warmer, but being in the trees the climate is warmer, and it’s also a chain of relatively small lakes that have got drainage systems going through them, and they therefore don’t freeze as well as the large lakes out in the barren lands. On a natural basis, at the end of the winter we might have about 40 inches of ice on the lakes in the south, whereas we have something like 90 inches of ice by the time we get up to the mine site at Lac de Gras.

In order to deal with that on a going forward basis where there are new mines being created up there – DeBeers has just opened its Snap Lake project – there are other mining operations that are under consideration up there. So the concept now that is being developed is to have what is referred to as a seasonal land road covering the lower portion of the road, taking it up to the point where it leaves the treeline. This road would traverse the land and cross some rivers. The rivers would have temporary bridges on them. The road wouldn’t be useable during the summer, therefore it would prevent it from being used by hunters, for example, and it would therefore minimize its impact on wildlife. It would actually traverse the same corridor that the current winter road is placed in.

But in this way, we would get away from the unreliable winter road and replace it with a reliable land-based road system. So that is the plan. Does that explain it?

Gary North – Canadian Press

What would be the cost and the regulatory review implications of that?

Bob Gannicott

Too early to say on the cost, but not really excessive when compared with the cost of maintaining the portages between the lakes and even all of the flooding that goes on on those southern lakes in order to build up ice thickness to unnatural levels. So it is not considered to be a significant additional cost, particularly shared between all of the operations that are up there.

The permitting challenge, because it occupies the same corridor, the same corridor the current winter road is in, it is not anticipated to be particularly difficult. But frankly, permitting issues, one can never predict exactly where that process will go. We don’t see it, on a technical basis, it should not be a challenge from a permitting point of view.

Gary North – Canadian Press

Thanks very much.

Operator

Your next question comes from Steven Butler - Canaccord Adams.

Steven Butler - Canaccord Adams

There were three sales in the fourth quarter of fiscal '07, yet mining revenues were only $81 million versus $90 million in the previous two quarters, roughly. Can you explain that variance?

Bob Gannicott

It has to do with part of the high-end value parcels of diamonds, we were able to sell out early, as it were. We were able to get them into the third quarter, but of course that took them off of the fourth quarter sales.

So, it’s been obviously in our best interest, to move the revenues forward.

Alice Murphy

Steven, as well as we go forward, we used to have just ten very distinct sales and we are going to have a continuing blurring of what is a distinct sale as we increase our international operations and continue to add to our Indian sales presence. So in early days, when you thought of 2-3-3-2 or something like that, that sort of is less clear going forward, although there is certainly always the majority sale.

Steven Butler - Canaccord Adams

You are saying there might be some mini-sales on the side?

Alice Murphy

It’s not so much a mini-sale, it’s just that as you carve out certain sales particularly in India, that is a subset of a greater sale and is not necessarily coincident from a timing perspective in the quarter.

Steven Butler - Canaccord Adams

Could you roughly say what additional costs were your share of costs at Diavik for the early closure of the winter road last spring?

Bob Gannicott

I think it might total to about 40 split between 20 on the operating cost and 20 on the capital.

Steven Butler - Canaccord Adams

Your share?

Bob Gannicott

Yes.

Steven Butler - Canaccord Adams

Would some of that have been back end weighted on the operating costs in the year?

Bob Gannicott

Obviously, as you can imagine, the fuel was flown in on an as needed basis so at the beginning, there were still fuel in the tanks and so the fuel flying was back loaded into the fourth quarter.

Steven Butler - Canaccord Adams

Right, okay, so Q3 and perhaps even more of an impact in Q4 it sounds like?

Alice Murphy

Each of our quarters took the brunt of that for different reasons.

Steven Butler - Canaccord Adams

The earliest caller asked a question about the Winston, I guess we can almost derive it by looking at the segment that you disclose your segmented mining non-cash costs and we can deduct them therefore, but the Winston additional deprecation, Alice, can you say roughly what that is on the allocation? It sounds like the allocation of purchase price, is that what we’re talking about?

Alice Murphy

No, what I was talking about is that when you have an acquisition you have to fair value all of the assets including inventory, and as you increase the value of that and then it goes through the sales cycle, you need to amortize that higher valued goods which then depresses the margin. It is purely an accounting issue, but it is a mandatory accounting issue.

If you look at our balance sheet now you can see that we also brought in goodwill and intangible, so that raised that portion of the balance sheet by $142 million. That is just part and parcel of purchase accounting and it just needs to flow through.

Steven Butler - Canaccord Adams

Bob, the last question here on the reserves for year end, have they been calculated yet or will we see that in the disclosure in your annual report?

Bob Gannicott

No, I am afraid that is a new mine plan issue, actually, because of course A-21 is such a significant factor. So a real kind of reappraisal of all reserves, if you want to call it that, await the valuation of the bulk sample from A-21. That bulk sample is being collected at the moment, but probably we won’t have a valuation result from it until the end of May or early June.

Steven Butler - Canaccord Adams

So, at that point we will probably have an overall reserve update?

Bob Gannicott

Absolutely.

Operator

Your next question comes from Brian MacArthur - UBS.

Brian MacArthur – UBS

Just a follow-up on a few of the previous callers. The comment on the 2-3-3-2 sales and now we are getting maybe some Indian side sales. I assume though it’s still going to be the 2-3-3-2 to the same extent as before, just because the big stones which are most of the value will still go on that sort of sales cycle, or will just come out whenever they come out, is that right?

Bob Gannicott

Well I think the practical reality is as soon as we pick up diamonds that are delivered down to Toronto, the large diamonds we generally have got sorted and ready for sale two weeks later. The rest of it takes at least the full five-week cycle and of course the sorting cycle with respect to India is offset because we have to ship the goods to India.

There are also special diamond cleaning issues that go into that. What Alice was alluding to, which is perfectly correct, is that this blurring is really the way to describe this in the sense that instead of having discreet sales we are actually selling different diamond items at varying times throughout the month. So it will tend to smooth things out somewhat.

Brian MacArthur – UBS

Okay well that’s great. I think that kind of explains the revenue side. Just a follow-up on one of the previous caller’s question, they asked about the cost of $25 for the year for the cost per carat. Is that cost matched to the production that you do each quarter, or is that the actual inventory cost that is flowing through the income statement?

Alice Murphy

That’s related to the production.

Brian MacArthur – UBS

So again, that’s lagging through which is kind of what you are talking about too, that comes through at a different time as well?

Bob Gannicott

Right.

Brian MacArthur – UBS

The next question then, Alice you mentioned talking about the $6.3 million deferred comp for the acquisition in SG&A for Harry Winston. That to me though, is that one-off?

Alice Murphy

Yes, very much so.

Brian MacArthur – UBS

Okay so that part of the acquisition is out the way. We just clear that out and going forward what we are talking about is the fair value of the acquisition and the inventory that was written up and we have to ride that through for the next?

Alice Murphy

We have to ride it through the terms as we sell that underlying inventory.

Brian MacArthur – UBS

Right. Now it looked to me and what I did -- and you sort of gave what the margins would be ex this whole situation -- it looked to me like the non-cash went up by about $8 million for the depreciation in Harry Winston year over year. Is that $8 million, that’s obviously reflecting some of that acquisition to the cost of goods sold, but is there also a higher net base as a result of the acquisition going forward, or is the net higher base just the result of adding stores over time?

Alice Murphy

It’s adding stores, we are adding stores as you know. That’s going to run through our P&L and then we also have this separate step-up component.

Brian MacArthur – UBS

Okay, so that eight or ten I am calculating though, at the moment is not the full step-up going forward, it’s a combination of this inventory acquisition that we have got to run through the cycle once, not the full amount, if you see what I am saying. I should take depreciation up by whatever it is, $8 million or $10 million on an ongoing basis.

Alice Murphy

I don’t want to give you your numbers, but I will say that just from an '04 base, if you look at Q4, our underlying margin was 52% compared to our reported margin of 47%. So if that gives you some assistance and if you would like to give me a call back later on, I would be happy to.

Brian MacArthur – UBS

Because that’s exactly what I was trying to get at, is obviously what the true margin is at the end of the day going forward. That would be very, very helpful.

Final question, a totally different issue. Bob, you talked about potential good results around the current pipes and lower down that might be helpful in the longer term. Is there any other news on any of the other pipes on the property? Was there any work done there? Anything of interest outside the four main pipes of the property?

Bob Gannicott

No, nothing that I would say points to potentially economic results.

Brian MacArthur – UBS

Great, thank you very much.

Operator

Your next question comes from Tanya Jakusconek - National Bank.

Tanya Jakusconek - National Bank

First just on the cash cost for this year, I know we had $25 a carat for the past year. Is that something we should look at for this year?

Bob Gannicott

The big issue was the winter road, the costs of the failure of the winter road. As I said, it added $20 million to our share of operating costs.

Tanya Jakusconek - National Bank

So if I was to ex that out, that would be a normalized value to use?

Bob Gannicott

Yes. I mean, we completed the winter road this year successfully, everything is already done.

Alice Murphy

But of course, there are lots of other factors so whether or not it is $25, $23 or any other number, again, we defer to your modeling.

Tanya Jakusconek - National Bank

Just on the reserves and resources, RTZ did put out some ore reserve estimates for year end, and from their reserve estimates it didn’t appear that Diavik replaced reserves. It looks like we fell from about 90 million carats down to about 81 million.

Bob Gannicott

Of course the issue, as I said earlier, the big issue now is bringing A-21 into the reserve base.

Tanya Jakusconek - National Bank

I just wanted to make sure that I hadn’t misunderstood, because the reserves that were reported by RTZ did fall, the inferred resources remained at about 23 million carats and I know that A-21 is almost 15 million carats. I am just wondering if the focus from now until May when you put out your revised numbers is just the focus on moving that A-21 from the inferred category to reserves, and therefore just replace what we had from year end last year.

Bob Gannicott

There are also these other extensions that have been identified through some special seismic work. There will be work going on to bring those into the resource base. At the moment, they are not in any category. They are just exploration, identified at the exploration level, they are not in inferred resources. They have no formal categorization.

Tanya Jakusconek - National Bank

So then in May, we look forward to have A-21 or part of it into the reserve base, and then some of these other extensions maybe into the inferred category?

Bob Gannicott

I think the other extensions beyond A-21, that will simply be an ongoing work program that goes on through the year, and I am not going to make any prediction about when it might be acquired into the resource.

Tanya Jakusconek - National Bank

Do we have maybe a number from Alice in terms of how much money is being spent on exploration this year up at Diavik.

Alice Murphy

Yes, I do have that number, Tanya. Hang on a second. I think our share going forward on exploration, our development costs are going to be about $62 million and that is going to be prework and underground. And then from sustaining, environmental basis we are looking at another $34 million or so.

Tanya Jakusconek - National Bank

Bob, just a comment on the diamond market. I know you have mentioned we have seen the mine supply, there isn’t much growth and demand continues to grow. Can you talk a little bit about just what you are seeing in pricing in the market right now? I mean some of the lower goods, I read as a lot of pressure from some of the inventories being dumped – do you have any comments on that?

Bob Gannicott

I would say the diamond market continues to bifurcate, if you like. I mean, obviously there is a complexity to it. There are whole different sets of sizes and qualities, as you know, that get sold on a rough basis and therefore get turned into polished. The strongest part of the polished market has been the better quality, plus 2 carat stones, basically the kind of things that Harry Winston and other luxury retailers use.

The items that have been more under pressure have been the cheaper diamonds, ones with lower quality both in color and clarity and in the intermediate sizes. The watch business with its demand for small diamonds, small, high quality diamonds, has kept prices up there. At the other end, the plus 2 carat – or larger than a carat, really – on a polished basis, high quality diamonds are kept well up by the demands of the top end retailers.

It is the street jeweler type of goods that have been under more price threat. Fortunately, our revenue base is more weighted towards the better-quality goods.

Tanya Jakusconek - National Bank

The rough prices have exceeded again the polished prices. Is that what you are seeing?

Bob Gannicott

No, I wouldn't say that is the way to look at it. The rough market moves more immediately than the polished market. So in other words, a gradual trend in the polished market of increasing prices will suddenly become a speculative trend in the rough market and the price will rise very quickly on the items that are delivering that kind of material.

Frequently, the rough market then has to adjust and then come back on again. It is just more immediacy to the rough than to the polished, but obviously these two things are linked together.

Operator

At this time, there are no more questions in the queue and I would now like to turn the call back to management for any closing remarks.

Bob Gannicott

Thank you all very much for listening in and thank you for your questions. We look forward to the continued positive outlook from where we sit at Aber. Thank you.

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